Sunday, October 21, 2012

Krugman Doesn't Get The Lessons That Latvia Offers

Paul Krugman criticize those who point to Latvia as an example of how austerity can be associated with growth by pointing to how real GDP is still significantly below, and the unemployment rate significantly above, the pre-crisis level.

But the issue here isn't whether or not Latvia should be content with the current state of affair in its economy, as far as I know no one has asserted that they should be (and I certainly don't think they should be content). The issue is what effect the austerity measures had, and when you evaluate a certain policy, you should compare current GDP and unemployment not with some previous cyclical peak, but with the point in time when the policy was implemented. And Latvia didn't implement austerity in 2007 or 2008, they implemented them mostly in 2010 and 2011. And GDP grew and unemployment fell significantly in both 2010 and 2011.

That alone doesn't of course prove a causal link between austerity and expansion, just like the economic contraction in some other countries that have implemented austerity doesn't prove a causal link between austerity and contraction, as there are other factors that either negatively or positively affect outcome, but the point is that first of all a minimum requirement of empirical testing is that it compares GDP and unemployment in the time period right before the policy was implemented with current results, and secondly that the Keynesian assertion that austerity is always empirically associated with negative growth is simply false.

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